CSA with China: Pakistan looking for alternative international currency?

As the international financial crises, originating from the United States and Europe, question the status of the dollar as a reliable currency for international trade and investment, Pakistan like many other risk-averse countries of the world has started looking for alternative options.
The signing of Dec 23rd Currency Swap Agreement (CSA) between the central banks of Pakistan and China, an emerging economic giant of our time, was partly aimed at enhancing role of Chinese Yuan in international trade and investment.
“The principal objective of these swaps is to promote the use of regional currencies for trade settlement purposes and specifically in the case of China, it is to enhance the role of the Chinese Yuan in international trade and investment,” said Governor State Bank of Pakistan (SBP) Yaseen Anwar in a statement issued Thursday.
Explaining the features and modus operandi of CSA, Anwar said the agreement represented a significant achievement for both governments in promoting and enhancing not only bilateral trade, but also the opportunity to significantly increase investment in Pakistan going forward.
He said CSA is executed for a tenor of three years in respective local currencies, Rs140 billion and Chinese Yuan 10 billion. This is the second CSA that SBP has signed, the first one being with central bank of Turkey on November 1 this year. “While these are strictly bilateral arrangements, the precise terms and conditions of each of these CSAs are confidential between two central banks,” governor SBP said.
China’s concurrent Yuan local currency settlement programme was also consistent with the underlying currency swap objectives. The latest CSA between Pakistan and China also reflected similar objectives of promoting trade and investment in bilateral currencies, he said.
Objectives and structure of CSA:
The objective of the swap is to 1) promote bilateral trade, 2) finance direct investment between the two countries in the respective local currencies of the two countries and 3) any other ‘purpose’ as mutually agreed between the two central banks. Since CSA is a bilateral financial transaction, all terms and conditions apply equally to both countries and the
pricing is based on standard market benchmarks, which are widely acceptable in the respective domestic markets of the two countries. The following are more details on the structure of the transaction:
1) Both central banks will have the ability to draw on the swap line any time during the tenor of the swap.
2) SBP can purchase CNY from PBC against its local currency (PKR), and repurchase its local currency with the same CNY on a predetermined maturity date and exchange rate. Similarly PBC can also purchase PKR against CNY. Standard market pricing will apply on the date of utilisation. Like any swap, the pricing is linked to interest rates differentials between the two currencies.
3) However, drawing under the swap line by either central bank will be contingent on 1) bilateral trade being denominated in local currencies, or 2) financing of direct investment between the two countries.
SWAP UTILISATION:
The announcement of the currency swap agreement between the two central banks will give a positive signal to the market on the availability of liquidity of the other country’s currency in the onshore market. This means that for example, SBP will have the ability to draw on the swap line and provide Chinese Yuan to banks in Pakistan. Banks will on-lend this liquidity to importers/exporters involved in trade denominated in Yuan. At maturity, the importer/exporter will repay the foreign currency to the lending bank; and the bank will repay to the respective central bank.
About the process Governor SBP said utilisation of CNY in Pakistan on account of CNY/PKR swap: SBP will lend CNY to banks which will on-lend to: On the maturity date of the letter of credit (LC), importer will pay off the overseas supplier by borrowing in CNY. Assuming borrowing is for six months, the importer will save on the rupee cost and after six months the importer will buy CNY against PKR and pay off CnY loan. Availability of onshore CNY financing will encourage imAbout the process Governor SBP said utilisation of CNY in Pakistan on account of CNY/PKR swap: SBP will lend CNY to banks which will on-lend to: On the maturity date of the letter of credit (LC), importer will pay off the overseas supplier by borrowing in CNY. Assuming borrowing is for six months, the importer will save on the rupee cost and after six months the importer will buy CNY against PKR and pay off CNY loan. Availability of onshore CNY financing will encourage importers to open CNY denominated LCs. Once the contract is established, the exporter will borrow in CNY, sellporters to open CNY denominated LCs. Once the contract is established, the exporter will borrow in CNY, sell CNY against PKR and utilise PKR for its local operations.
UTILISATION OF PKR IN CHINA:
Same concept will apply to PBC drawing PKR against the swap line and lending the same to banks in China. China has significant investments in various projects in Pakistan and Rupee proceeds of the swap can be channelised to such long-term projects in Pakistan via Chinese banks.